A new capital gains tax in Washington was ruled unconstitutional by a lower court judge on Tuesday, likely sending the controversial legislation to the state’s Supreme Court.
Brian Huber, a judge for the Douglas County Superior Court in central Washington, said in a written decision that the tax “shows the hallmarks of an income tax rather than an excise tax” as argued by state lawmakers.
As a result, he said it exceeds the maximum annual property tax rate of 1% — income tax is legally a property tax in Washington — and “violates the uniformity requirement” for taxes as established by the state’s constitution because it imposes a 7% excise tax on capital gains, but only for gains of more than $250,000.
Attorney General Bob Ferguson said his office will appeal the judge’s ruling.
“There’s a great deal at stake in this case, including funding for early learning, child care programs, and school construction,” Ferguson said in a statement. “Consequently, we will continue defending this law enacted by the peoples’ representatives in the Legislature.”
Collin Hathaway, president of the Opportunity for All Coalition, said in a statement that “Judge Huber saw through the state’s attempt to enact this illegal capital gains income tax under the guise of an excise tax.”
Added Jason Mercier, director for the Center for Government Reform, in a blog post: “If only someone had warned lawmakers that the IRS and every other state in the country unequivocally say a capital gains tax is an income tax. Perhaps they’ll pay attention now that the courts have said the same.”
The tax, passed by lawmakers in April, was estimated to affect about 7,000 individual taxpayers and raise more than $440 million annually in fiscal year 2023. Early education and childcare would receive a majority of the funds.
Under the law, long-term capital assets such as stocks and bonds (held for more than one year) would be taxed if profits exceed $250,000. Real estate gains, retirement accounts, and some sole-proprietor businesses are excluded, among other exemptions.
Here’s an example provided by the Attorney General office:
For example, if a person bought stock for $100,000 and sold it 10 years later for $400,000, they would have a capital gain of $300,000. The first $250,000 of that amount would be exempt from tax, so the person would owe the 7 percent tax rate only on the remaining $50,000 in gains, for a total tax payment of $3,500 on the $400,000 sale.
The tax faced two lawsuits that were consolidated. The first was filed by the conservative Freedom Foundation; the second filed by former Washington Attorney General Rob McKenna, representing manufacturing businesses and the Washington State Farm Bureau, among others.
Opponents of the tax say it is illegal under the Washington state constitution, which sharply limits income taxes. Supporters counter that the tax isn’t an income tax at all, but an excise tax which is common and legal in the state.
The Seattle tech community was at odds with the tax. Some see it as either a necessary change to the state’s regressive tax system or, alternately, as a startup killer because stock frequently is used as compensation.
A letter published last year by the Washington Technology Industry Association, which represents more than 1,000 tech startups and larger companies, warned the tax will “remove a meaningful attraction and retention mechanism” for startups and “harm our competitiveness.”
But others believe the tax is a net-positive for the state’s business ecosystem.
“By siding with a tiny number of extremely wealthy residents, the lower court is ignoring widespread public support for helping working families find childcare and providing children with the education they need to succeed in life,” Treasure Mackley, executive director of Invest Washington Now, said in a statement.
The tax is an important issue for the tech community as it relates to stock awards, which are often tied to compensation. After the law was passed, some executives and business owners cashed out their stock holdings, according to Seattle-area wealth managers who spoke with GeekWire late last year.
Judge overturns Washington state capital gains tax by GeekWire on Scribd